Wednesday, August 15, 2007

[PBN] Biodiesel's Nightmare: Renewable Diesel


Until algae farms move from the research and demonstration stage,
biodiesel usage is going to be tightly constrained by available
feedstock. The feedstocks for biodiesel are oils and fats, which
naturally occur in quantity only in animals or the seeds of plants. As
such, the quantity of oil available is much smaller than the sugars,
starches, and cellulose which occur not only in the seeds and fruits of
plants, but also in the stems and leaves, and can be used to make
ethanol. Because sugarcane contains the best ethanol feedstock, sugar
in the stem (not just the fruit) of the plant, Brazilian ethanol can
compete effectively with gasoline without subsidies.

From Trash to Cash

Biodiesel can also compete with diesel on the basis of price, in large
part because it is much simpler to convert oils and fats into biodiesel
than it is to convert sugar into ethanol, and the oils commonly used for
biodiesel today were essentially treated as low-value byproducts (e.g.
soybean oil) or zero-value waste products (e.g used cooking oil) of food
production. When petro-diesel cost $1 a gallon, biodiesel was limited
homebrew in the garages of a few hippie types, but now that it is around
$3 a gallon, turning low value oils and fats into high value fuel can be
big business.

How big could the biodiesel business get? With US production of
soybeans at about 3 billion bushels, if the entire soybean crop were
converted into biodiesel at 1.4 gallons per bushel, we would have about
4.2 billion gallons of biodiesel, or around 6.5% diesel fuel consumption
in the US. There are many other potential feedstocks for biodiesel,
but soy oil accounts for most of US oil production, so we can safely say
that domestic biodiesel production will not exceed 10% of domestic
consumption without some new source of feedstock. In fact, potential
biodiesel supply is falling, since farmers are changing their crop
rotation to include less soy and more corn for ethanol. All told, the
potential demand for biodiesel far exceeds the potential supply, which
will be limited by the supply of potential feedstocks, instead.

Currently biodiesel supply is limited by production capacity, but in the
long term, as more production facilities are built, supply will be
limited by available feedstock. At this point, commodity arbitrage will
set the price of biodiesel close to its main substitute, petro-diesel,
and the price of commodity oils will follow along for the ride, but low
enough to allow biodiesel producers to earn a return on investment.

New Kid on the Block

The above analysis assumes that biodiesel production is the best way to
take vegetable oils and fats, and make them into transport fuel. This
may not, in fact, be the case. Last spring, ConocoPhillips (NYSE:COP)
announced a deal with Tyson Foods (NYSE:TSN) to use fat from Tyson's
rendering plants to make "renewable diesel" fuel in COP's refineries.
The key point here is that COP is making what they call "renewable
diesel" not conventional biodiesel. They developed their renewable
diesel process using soy oil in Ireland, using their existing oil
refinery there.

I first heard of this process last October at an NREL presentation (they
called it "Green diesel" and could not identify COP as the oil company
they were dealing with,) but details remain sketchy. The fact that they
refer to the process as a "proprietary thermal depolymerization
production technology" and the fact that they are using existing
refinery infrastructure should cause alarm to biodiesel firms and

Why should this cause alarm? Because COP claims its "renewable diesel"
is chemically equivalent to conventional diesel. If this is true, it's
quite possible that it has a lower cloud point than biodiesel, and so
could be used at a broader range of temperatures. In addition, since
COP is using conventional refining equipment, they may also be achieving
higher energy yields.

According to NREL's Overview of Petroleum and Biodiesel Lifecycles,
Biodiesel conversion requires 80 kJ of energy for every 1000 kJ of
energy in the biodiesel, while petro-diesel requires only 64 kJ to
produce an equivalent amount of fuel. While the difference in energy
costs is fairly minor, transportation fuel is a commodity business, and
COP's ability to use the existing pipeline infrastructure into which
their refinery is already integrated, as well as its ability to avoid
the large capital expenditures required to build a biodiesel refinery
from scratch are likely to give them a large cost advantage over
biodiesel producers in this thin margin business.

With the exception of small biodiesel producers using local and
distributed biodiesel feedstocks such as waste vegetable oil from
restaurants, I expect that petroleum refineries will end up having an
economic advantage making renewable diesel in comparison to conventional
biodiesel producers. This means that commodity oils and fats available
in large enough quantities to interest refineries will be bid up in
price to a point where less efficient biodiesel producers will be unable
to operate profitably.

All of this may happen remarkably quickly as well. ConocoPhillips and
Tyson say that their deal could ramp up to 175 million gallons by 2009,
or about 10% of United States 2006 biodiesel production. How soon will
refineries be competing directly with biodiesel producers for soy and
other vegetable oils?

While we can only speculate about the relative economics of renewable
diesel and biodiesel, having a new competitor cannot be good for the
biodiesel industry. Biodiesel producers might be sustained by federal
biodiesel tax credits, but depending on government subsidies is not a
sustainable business model, especially when you are competing with an
industry with a long track record of successful lobbying.

The likely winners I see are the suppliers of feedstock. When the deal
was announced, a Tyson spokesman said he expected the deal to increase
annual earnings by between $.04 and $.16 per share.

DISCLOSURE: Tom Konrad and/or his clients do not have positions in any
of the companies mentioned here.

DISCLAIMER: The information and trades provided here are for
informational purposes only and are not a solicitation to buy or sell
any of these securities. Investing involves substantial risk and you
should evaluate your own risk levels before you make any investment.
Past results are not an indication of future performance. Please take
the time to read the full disclaimer here.

Check for earlier Pacific Biofuel posts:

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